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Staff Insights 2017/11

Central Bank
Digital Currency:
A Monetary Policy
Perspective
By Nurjannah Ahmat, Sabrina Bashir

Monetary Policy Department

September 2017

Bank Negara Malaysia’s Staff Insights provide preliminary analysis on topical issues.
Any views expressed within are solely those of the author(s) and do not necessarily
reflect the position of Bank Negara Malaysia.
 Central Bank Digital
Currency: A Monetary
Policy Perspective

A. Introduction: If you can’t beat new as most central bank money is already
Bitcoin, join ‘em?
With the rising interest in and usage of
private digital currencies (e.g. Bitcoin), a
policy question that has arisen is whether
central banks should consider issuing official
digital currencies (central bank digital
currency, CBDC1). Consequently, research
has been initiated globally to evaluate the
costs and benefits of the issuance of CBDCs
to the functioning of the economy, and its
implications on the central bank mandates
of monetary and financial stability and most
directly, currency issuance and payment
systems. This article reviews the current
thinking on the potential impact of issuing
CBDC to the conduct of monetary policy2.
B. Definition: What is CBDC?
CBDC, in essence, is central bank cash
(banknotes and coins) made available in
electronic form. Yet, “digital currency” is not
“digital”. All commercial bank deposits or
reserves with the central bank represent
digital claims (monetary value stored
electronically). In the current setup, only
member banks have access to central bank
money and related payment systems such
as Real-time Electronic Transfer of Funds
and Securities System (RENTAS) in the
case of Malaysia.
Therefore, the key innovation with CBDC
is the potential for non-banks (individuals
and firms) to hold direct accounts with
the central banks or to transact directly
with one another using the CBDC as a
legal tender. This has been made possible
by the technology used in private digital
currencies, namely the distributed ledger
technology (DLT)3.
Given the proposed underlying DLT, CBDCs
could be thought of as a “government
cryptocurrency”. However, it should be
distinguished from e-money, which is

1
CBDC is also sometimes interchangeably referred to as digital base money, for example in Mersch (2017).
2
Featured in research by Barrdear and Kumhof (2016), Bordo and Levin (2017), and Engert and Fung (2017), among others.
3
Private digital currencies allow people to transact anonymously, directly and quickly with each other without the need for a trusted third party due to its underlying technology, the
distributed ledger technology (DLT). DLT is a distributed database that allows for decentralised bookkeeping (i.e. processing, validation and authentication of transactions). A DLT keeps
all history of transactions in a tamper-proof way and makes them publicly available as the current transactions are linked to the chain of all the previous transactions. The DLT is seen
to have a potentially wide range of application, from the financial services sector (e.g. settlements) to retail (e.g. loyalty and rewards) and health-care sectors (e.g. data management).
See Andrade and Ketterer (2016); Fung and Halaburda (2016); and Monetary Authority of Singapore (2017).

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Central Bank Digital Currency: A Monetary Policy Perspective
merely a payment system innovation enabling
cashless transactions. The key features of
these forms of payment are in Table 1.
C. Central bank initiatives
CBDC (Diagram 1)
Central banks have shown varying levels
of interest and progress in CBDC, with
different motivations. Where the US,
Sweden, China and Ecuador are interested
in the CBDC for day-to-day transactions
by the public, experimentations in Canada
and Singapore are focused on improving the
efficiency of the wholesale payments and
settlements system.
There has also been mixed sentiments with
regards to the applicability and reliability
of CBDC. Bank of Canada staff research
cautions central banks to proceed carefully
Table 1
Comparison of Private Digital Curencies, CBDC and e-Money
Private digital currencies /
Virtual currencies
• Digital representation of value, not
Defi nition issued by a central bank, credit institu-
tion or e-money institution, which, in
some circumstances, can be used as an
alternative to money
• Cryptocurrencies are a subset of
private digital currencies, which uses
cryptographic proof for its verification
process
Key aspects • New currency
• New payment system (DLT)
• Bitcoin
Examples
• Ripple
Source: European Central Bank (2015), Virtual Currency Schemes - A Further Analysis; and Bank for International Settlements Committee on Payments and
Market Infrastructures (2015), Digital Currencies
PAGE 2
given operational complexities and
uncertainties of retail CBDC. Moreover,
Bank of Canada, Bank of England and
Sveriges Riksbank have communicated the
need for multi-year research before making
on a decision on issuing CBDC. Similarly,
European Central Bank senior officials have
treaded with a guarded stance, posing both
the merits and dangers of central banks
progressing either too expeditiously or
adapting too slowly given rapid technological
changes.
D. What would CBDC look like?
(Diagram 2)
While the CBDC would be underpinned by
the use of DLT, researchers have proposed
different frameworks for how CBDC could
be implemented. One key consideration is
the verification of transactions.
Central bank digital currencies E-money / mobile money
• Monetary value stored electronically • Actual monetary value stored in an
that is a liability of the central bank electronic device that can be used
and can be used to make payments to make payments across retailers
and purposes
• New currency • A form of cashless retail payment
• New payment system (DLT) system
• Dinero Electronico (Ecuador) • Touch‘n’Go card (Malaysia)
• Octopus card (Hong Kong)

In one framework resembling private
digital currencies, CBDC would involve
“digital tokens” that can be transferred
directly from payer to payee, and
are verified by third parties. This
“decentralised” CBDC would then function
just like physical banknotes and coins, as it
can be used directly and transactions can be
done anonymously. However, for practical
reasons, most research suggests limiting
the DLT verification process to selected
participants, such as among commercial
banks. Furthermore, the central bank
could also serve a “notary” role, by auditing
transactions and verifying that funds
are available.
The other proposed framework would
involve private individuals and firms
having an account with the central bank,
Milestones in CBDC by Other Central Banks
Interest
Sveriges Riksbank
Detailed research plan on
issuing retail CBDC (e-krona) as
a complement to cash. Decision
on issuing CBDC will be made
by 2019
Bank of Estonia
Announced intention to launch
"estcoin" via initial coin offering
(ICO), as part of its e-Residency
program (established in 2014)
that allows foreign investors to
virtually site their businesses in
the country
Bank of Japan
Collaborating with the European
Central Bank to explore how
DLT could be applied to
financial market infrastructures
(e.g. interbank payment system)
(Dec 2016)
Less optimistic about readiness
of DLT for real-world application
and to be used by central banks
Source: Central bank websites, newsflows, Bordo and Levin (2017) and Andrade and Ketterer (2016)
Central Bank Digital Currency: A Monetary Policy Perspective
and all transactions between accounts would
be validated and processed by the central
bank. Under this “centralised” framework, the
CBDC could be thought of as an application
of a payment system like RENTAS, but to the
wider economy. The central bank would play
a similar role to commercial banks, which
intermediate funds between accounts across
its balance sheet.
Given the shift towards “digital” currency,
it raises the opportunity to consider
whether CBDC should be paid interest
at a rate similar to other risk-free assets
such as government bonds. If it is not
paid interest, CBDC would be analogous
to physical cash. This remuneration
aspect would have important bearing on
how it affects monetary policy, which is
described in the next section.
Diagram 1
Research (Published) Experimentation Implementation
Bank of England Bank of Canada Central Bank of Ecuador
Quantified the potential Simulated a decentralised CBDC for large First central bank to implement
macroeconomic effects of CBDC interbank settlements using DLT, but found centralised CBDC for the public
(Barrdear and Kumhof (2016)) some gaps. Next phase is focused on building ('Dinero Electrónico‘). Under this
a modified DLT to address gaps (Project scheme, the CBE exclusively
Jasper) (Dec 2016) manages e-money, and allows
citizens to hold an e-money account
at the central bank (Dec 2015)
Monetary Authority of Singapore
Implementation met with mixed
US Federal European Successfully simulated a decentralised CBDC success, riddled by slow take-up rates
Reserve Central Bank for large interbank settlements (Project Ubin) and concerns raised on its reliability
(Mar 2017). Next phase is focused on fixed
Staff research on applications of income securities trading and settlements and
DLT on payments, clearing, cross border payments
and settlement; conceptual
framework on potential CBDC People’s Bank of China
Exploring technologies to establish a CBDC.
Reported to have begun conducting trial runs
of its prototype cryptocurrency among
retailers (Feb 2017)
Central Bank of the
Russian Federation
Conducting pilot runs to proof the viability of
different CBDC schemes on various
technological platforms (June 2017)
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Central Bank Digital Currency: A Monetary Policy Perspective

E. Impact on monetary policy their money in bank deposits as opposed

from the introduction of CBDC
Some general observations have been made
on the potential impact to monetary policy
from an introduction of CBDC.
For example, CBDC could unlock central
banks’ ability to capture rapid, real time
economic surveillance, which would greatly
inform monetary policy formulation. This
is due to the underlying DLT property that
preserves all transactions, and the virtually
instant transactions immediately captured
by the ledger.
As described earlier, CBDC could
function like physical cash and receive
no interest payments. In normal times,
economic agents would prefer to keep
to CBDC given that bank deposits
receive interest payments. However,
in the tail-risk event of economic
instability or a system-wide bank run,
CBDC would be another option in
addition to cash. It is fully guaranteed
by the central bank with no risk of
losing its face value and easily stored
in large amounts. This easy switch
to CBDC would speed up the bank
run. The consequent impairment to
financial intermediation would directly
weaken the efficacy of monetary policy.
On the other hand, researchers propose that
CBDC could receive interest payments for
the purpose of transmitting monetary policy
action directly to economic agents, which
increases the efficiency of monetary policy.

Diagram 2

Potential Modalities of the CBDC

Option 1
Value/Token-Based Design
CBDC tokens that would circulate
+ Decentralised Technology
CBDC can be transferred directly to
electronically and directly one another without direct Remuneration alternatives
between individuals without involvement of the central bank Interest-bearing vs Non-interest bearing
involvement of the central bank
Interest-bearing
Analogous to physical banknotes and coins Funds held in CBDC would pay
out interest
Option 2
Account-Based Design
Individuals and firms hold electronic
+ Centralised Technology
Central bank would process each CBDC
Non interest-bearing
Funds held in CBDC would not
funds in accounts directly at the central transaction by debiting and crediting pay out interest
bank, or through commercial banks across the central bank balance sheet

Analogous to RENTAS-like system for the whole economy, or a

central bank acting like a commercial bank

Pre-requisites for CBDC

Note: By design, a value/token-based CBDC would imply
• Central bank controls the money supply a decentralised system, while an account-based CBDC
• The CBDC system uses the distributed ledger technology, would imply a centralised system
potentially between a group of participants (e.g. banks)

Note: Based on Bordo and Levin (2017), Fung and Halaburda (2016), Mersch (2017), and Skingsley (2016)

PAGE 4

Under this modality, economic agents could
also switch to CBDC from bank deposits,
which could lead to a deposit outflow.
This outflow of deposits to CBDC could
motivate banks to compete for deposits,
which could in turn increase deposit rates
and thus also retail lending rates, despite
no increase in the policy rate.
Some advanced economies currently have
negative policy rates4, which are typically not
transmitted to retail deposit rates. But the
CBDC could perhaps be charged a negative
interest rate5, thus efficiently transmitting
to the economy the negative policy rate.
This would remove the so-called zero lower
bound problem6. However, a key caveat is
that given that CBDC is expected to only
be a complement to cash (see section F),
there could still be a limit to how effectively
this negative interest rate is transmitted.
If a negative interest rate on CBDC was
introduced at a large enough magnitude,
economic agents could end up choosing
to hold physical cash instead of CBDC. A
further counter-argument is that negative
returns on currency holdings could prove
to be unpopular with the public.
Finally, with CBDC, it could be feasible
for central banks to implement helicopter
money7 as an additional tool for monetary
policy – although whether such a policy
tool is warranted or desirable is beyond the
scope of this article.
In conclusion, the potential impact on
monetary policy from an introduction of
CBCD is unclear; and given limited CBDC
currently in existence8, pure conjecture.
4
Japan, Sweden, Switzerland and Denmark.
5
This could be done through reducing balances on economic agents’ accounts, or the CBDC not being redeemed at full value (Source: Skingsley (2016)).
6
A situation that characterises the difficulty for central banks to change short-term nominal interest rates to below zero to stimulate economic growth. This is because cash, which can
be thought of as being remunerated at 0%, can always be held as an alternative to negative interest rate bearing assets.
7
The concept of helicopter money was first introduced by Milton Friedman, and is broadly defined as the printing and distributing of money directly to individuals in the economy, in
order to boost economic activity.
8
Currently, only Ecuador has issued CBDC. See Diagram 1 for details.
9
Source: Mersch (2017) and Coindesk (Feb 2016), China’s Central Bank Weighing Blockchain Tech for Digital Currency
Central Bank Digital Currency: A Monetary Policy Perspective
F. Broad conclusions and relevance
to Malaysia
Research is still nascent
While the potential impact to the transmission
of monetary policy is recognised, this needs
to be analysed further. This analysis should
be balanced with implications in other
intersecting areas of central banking, and
also wider implications on the economy,
commercial banks and economic agents.
Cash is still king?
It is quite unlikely that cryptocurrencies
would replace cash transactions any time
soon. Pioneering work reviewed generally
concludes that CBDC, even if introduced
in the future, would likely be a complement
rather than a substitute to cash and bank
deposits.
Technological hurdles need to
be considered, as central bank
credibility must take priority
Fung and Halaburda (2016) questioned
whether “the central bank would have a
comparative advantage in issuing a digital
currency, given its lack of market and
technical expertise”. Conversely, People’s
Bank of China and European Central
Bank challenged whether the underlying
technology is advanced and reliable enough
to be applied by central banks9. The bedrock
of currencies is the trust that people
have in the central bank to preserve the
value of money. If the technology for
CBDC falls short in guaranteeing this
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Central Bank Digital Currency: A Monetary Policy Perspective

(e.g. cyber-security breach), the central circumstances under which the well-
bank risks losing its credibility. This is a being of people could be reduced by
key risk, in light of recent data thefts and its introduction”12. It is not compelling
hacking resulting in millions of losses enough for CBDC to be implemented
from cryptocurrency exchanges10. just because the technology allows for it.
The issuance of CBDC must be research-
CBDC must be welfare-enhancing driven and needs-based, with the aim to
unambiguously improve the well-being
of people.
“Just because [CBDC] is feasible
does not mean it is desirable”11 Each country’s response would
- David Andolfatto, Vice Governor, Federal
be unique
Reserve Bank of St. Louis Ultimately, the extent of country’s
responses and intervention with regards
To quote Bank of Canada Deputy Governor to digital currency and CBDCs would
Carolyn Wilkins, “If it simply provides vary, reflecting the different economic
another payment mechanism when structure, demographics, risk appetite, and
cash is a viable alternative, there are institutional capacity and framework13.

Issues for discussion

1) If each country’s response to digital currency or CBDC is unique, what could
Malaysia’s response be?
2) Will interest in digital currencies become widespread enough in Malaysia to
warrant consideration on issuing CBDC?
3) Should there be a global, concerted shift towards issuing CBDCs, where would
Malaysia stand on this issue?

Source: New York Times (Aug 2017), Identity Thieves Hijack Cellphone Accounts to Go After Virtual Currency; Fortune (July 2017), One of the Biggest Ethereum and Bitcoin
10

Exchanges Got Hacked

Source: Andolfatto (2015), Fedcoin: On the Desirability of a Government Cryptocurrency
11

Source: Wilkins (2017), Canada Explores Digital Currency: Fintech Collaboration Vital to Unlock Promise
12

Adapted from Fung and Halaburda (2016), which attributed the level and type of intervention of central banks to different histories, institutional structures and legislative authorities.
13

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 Central Bank Digital Currency: A Monetary Policy Perspective

References

Andrade and Ketterer (2016), Digital Central Bank Money and the Unbundling of the Banking Function,
Inter-American Development Bank

Barrdear and Kumhoff (2016; 2017), The Macroeconomics of Central Bank-Issued Digital Currencies, Bank of England

Bordo and Levin (2017), Central Bank Digital Currency and the Future of Monetary Policy

Chapman et. al. (2017), Project Jasper: Are Distributed Wholesale Payment Systems Feasible Yet?, Bank of Canada

Engert and Fung (2017), Central Bank Digital Currency: Motivations and Implications, Office of the Superintendent of Financial
Institutions and Bank of Canada

Fung and Halaburda (2016), Central Bank Digital Currencies: A Framework for Assessing Why and How, Bank of Canada

Mersch (2017), Digital Base Money: An Assessment from the ECB’s Perspective, European Central Bank

Monetary Authority of Singapore (2017), Project Ubin: SGD on Distributed Ledger

Skingsley (2016), Should the Riksbank Issue E-krona?, Sveriges Riksbank

PAGE 7
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